Ed Dolan's Econ Blog

Corporate Taxes: Don’t Beat Up on Apple: The Flaw is in the Law

This week it was the turn of Apple’s Chief Executive Tim Cook to sit in the Congressional hot seat. With lights blazing and cameras rolling, a bipartisan lineup of Senators grilled him about the relatively small amount of tax the company pays on its substantial corporate profits. According to a New York Times account of the hearing, Republican John McCain characterized Apple “as among America’s largest tax avoiders.” Democrat Carl Levin complained about the use of “ghost companies” to hide profits overseas.

Cook replied that Apple pays “all the taxes we owe — every single dollar.” He could have added that as Chief Executive, it is his fiduciary duty to look after the interest of his shareholders. He could go to jail if he passed up entirely legal methods of protecting their profits from the IRS. So don’t beat up on Apple. The flaw is in the law.

What exactly are the flaws in the corporate tax law?

The first is that the “corporate tax” is not really a tax on corporations. Yes, corporations can “pay” taxes in the sense that the check that goes to the IRS is printed with the corporate logo, but they can’t bear the economic burden of taxes, because they are not people. The entire burden of the tax ultimately falls on the corporation’s stakeholders—its shareholders, executives, workers, customers, suppliers and others.

Unfortunately, we don’t really know exactly which of these stakeholders bear what share of that burden. Economists used to assume that all or most of the burden of corporate taxes fell on shareholders. For a corporation operating a closed economy, that may have been a good assumption. However, when corporations operate in a global market, they are able to shift much of the tax burden to employees, up to 70 percent, by some estimates. That number may not be exactly right, but the shift is substantial. (For a more detailed discussion of the incidence of the corporate tax, see this earlier post.)

The second flaw with the U.S. corporate tax is that its marginal rates are too high and its loopholes are too many. At 35 percent, the top U.S. corporate tax rate is the highest in the world. No wonder companies try to avoid it. There are plenty of legal ways to do so: Hold profits overseas rather than bringing them home. License intellectual property on advantageous terms to subsidiaries located in low-tax jurisdictions. Take advantage of numerous other preferences, like accelerated depreciation of equipment. Eric Toder of the Tax Policy Center estimates that eliminating corporate tax preferences could potentially save $506 billion over five years. With fewer loopholes, we could cut the marginal tax rate to about 25 percent with no loss of revenue, he says.

To his credit, President Obama recommended doing just that in his recent budget message. Too bad he hasn’t said a word about it since.

The third flaw in the tax is the double taxation of corporate income. The corporate tax hits profits once, when a company earns them, and again, when it distributes them to shareholders. Congress has responded to the problem of double taxation with preferential personal income tax rates on capital gains and dividends, but as I discussed in another earlier post, that is the wrong approach.

What should be done? As an interim measure, by all means, close loopholes in the corporate tax and use the extra revenue to cut its marginal rate. (By the way, Cook says he endorses this idea, even if the result would increase Apple’s taxes.) The top rate could be cut even further if personal income from dividends and capital gains were taxed at the full personal income tax rate. If we reduced the U.S. corporate tax rate even to the OECD average of about 25 percent, there would be less incentive for companies like Apple to park so much of their profits in foreign subsidiaries.

An even better solution would be to eliminate the corporate tax altogether. For all of the economic distortions it causes, it doesn’t really bring in much. It now accounts for only 9 percent of total federal tax revenue, down from a post-World War II high of 30 percent. The government could recoup part of the revenue by taxing capital gains and dividends as ordinary income on personal income tax returns. It could make up the rest by closing other loopholes in the personal income tax, or by introducing new, broadly based taxes like a VAT or a carbon tax. (I will write more about those in future posts.)

Meanwhile, it is comforting to note that at least one Senator did get something right at this week’s hearing. “Instead of bullying Apple executives,” said Senator Rand Paul, “we should have brought in a giant mirror to look at the reflection of Congress. If you want to assign blame, look in the mirror and see who created this mess.”


8 Responses to “Corporate Taxes: Don’t Beat Up on Apple: The Flaw is in the Law”

Edward StevensMay 23rd, 2013 at 10:00 am

Thank you, for making the simple point that corporate taxes are just another cost of doing business and that the corporation , as with all its costs, passes them through; ot at least tries to pass them through. I have unsuccessfully tried to make that point for many years–you have done it it succinctly and lucidly.

George WellsMay 23rd, 2013 at 11:25 am

We have a problem of definition here. Dolan makes the case that a Corporation is not a person for tax purposes, but those same corporations make the case that they are de-facto persons for political purposes and should be allowed to manipulate the outcomes of elections by using their wealth and be protected under the First Amendment. I don’t think that corporations deserve to: “have it both ways.”

The USA could, and perhaps should, replace the corporate tax with a consumption/sales/value added tax while still maintaining a progressive income tax on biological people (albeit probably at much lower rates offset by the tax on consumption).

Jardinero1May 23rd, 2013 at 1:04 pm

The point is that, unlike real people, a corporation spends, invests or distributes every dime that flows through it. Corporations are inherently pass through entities. It makes more sense and is more efficacious to tax the people to whom the money passes to.

Daniel SiglerMay 24th, 2013 at 1:20 am

Except when the money moves over seas then different countries tax them. Or the money goes to the Cayman Islands or numerous other tax shelters and no tax is paid on it. Laws require companies to disclose earning, revenues, expenses, and so forth. Taxing companies at the company level makes the most sense. Taxes on corporations should help direct the money that to better pursuits.

SchofieldMay 24th, 2013 at 2:20 am

It's all very well talking about transferring the burden of tax onto income tax but as we saw in the Mitt Romney campaign and his refusal to publish up-to-date tax returns we were reminded that the rich especially have the means to engage in all manner of tax evasion schemes. In an age of global warming Robert Frank's proposal for a Consumption Tax in some shape or form looks to have merit to replace a whole plethora of taxes including corporation tax.

Ed Dolan EdDolanMay 24th, 2013 at 1:00 pm

There is a lot to be said for a consumption tax, I agree with you there. However, with respect to Romney, note that his tax avoidance is mainly enabled by features of the individual income tax law that allow low rates on capital income. I consider that taxation of all capital income (dividends, capital gains, "carried interest," etc.) at ordinary income rates to be a necessary corollary of reduction or elimination of the corporate tax.

jrj90620May 29th, 2013 at 11:59 am

Only if cap gains taxes are adjusted for real inflation.Otherwise,there is no limit to how high cap gains tax % can be,for long term holdings.Better to eliminated cap gains taxes and increase consumption taxes.This country needs more savings and investment and less mindless consumption.

Ed Dolan EdDolanMay 29th, 2013 at 1:17 pm

I agree that inflation can distort capital gains taxes, and yes, indexation is the way to go, but the situation is not quite as simple as sometimes thought. The problem is, inflation also distorts tax rates on other forms of capital income, including dividends and interest income. Under some circumstances, inflation can affect those even more strongly.

I discussed these issues in an earlier post, and concluded as follows: "The ideal solution to distortions caused by inflation would be to index the entire tax system. Indexation would have to cover not only all forms of investment income, but also taxation of ordinary income, real estate, inheritance, and everything else. But trying to remove the effect of inflation on capital gains taxes separately is likely to make things worse, not better."

For the complete argument, see heading 2 in this post: